Today’s record high farmland values have to be based on expectations of interest rates remaining low for an extended period, suggests two Kansas City Federal Reserve Bank officials.

In a recent report Jason Henderson, vice-president, Omaha branch executive, and Brian Briggeman, economist, wrote that they don’t believe that interest rates can remain nearly as low as current levels for a considerably long period.

“Farmland values often rise with persistently low interest rates and strong crop prices. Low interest rates lift farmland values by reducing the discount on the future income stream produced by the land. In addition, low interest rates depress the value of the dollar, which in turn boosts agricultural exports, raises commodity prices and enhances farm revenues,” the authors wrote.

“Since June 2010, U.S. corn and wheat prices have doubled due to strong export demand and tight crop inventories. In response, crop profits have soared to record highs, lifting Midwestern cropland values. Prior to the recession, farmland values were rising at the fastest clip since the 1970s. After jumping 20 percent in 2005, U.S. farmland values grew 7.5 percent annually from 2005 to 2008,” the Federal Reserve facts have shown.

What happened as of the fourth quarter of 2010, Federal Reserve surveys reported Midwestern cropland values jumped almost 20 percent above year-previous levels.

“When short-term interest rates fall, commodity prices rise, in turn boosting farm incomes. Since 1970, real net farm incomes were higher during times of low short-term interest rates, measured by the inflation-adjusted yield on the one-year Treasury security rates, lower agricultural exports, falling commodity prices, and cuts in farm revenues. From 1981 to 1987, the combination of higher capitalization rates and falling revenues contributed to a 40 percent decline in real U.S. farmland values, with even larger declines in nominal farmland values,” Henderson and Briggeman wrote.

“If similar events occur in today’s environment, farmland values could plummet,” the two contend. “For example, in eastern Nebraska, if capitalization rates return to their historic average of 7.5 percent and corn prices fall to $4 per bushel, then irrigated cropland values could fall nearly 50 percent to about $2,600 per acre. Other regions face similar risks.

Their conclusion was as follows: “Across much of the Midwest, rising farmland values have outstripped the increases in cash rents, raising questions about the sustainability of current values. In the long-term, future farm revenue expectations and interest rates should determine farmland values. Today, the interest rate risk to farmland values is high. Record high farmland values are based on expectations of interest rates remaining low for an extended period. As the economy strengthens, however, interest rates could rise, which may lift capitalization rates and lower farm revenues. Events such as these could become a recipe for falling land values and the erosion of farm wealth.”